Monday, December 9, 2013 / by Jennie Jackson
Is buying a home for your kids a good idea? This article by Betsy Schiffman goes over the advantages and disadvantages of this type of investment:
Buying A Home For Your Kids: A Good Idea?
Your kids have just graduated from college. They’ve moved to a new city where they’ve been fortunate enough to land reasonably well-paying jobs. The problem is that they don’t earn enough to live anywhere better than what strikes you as an overpriced tenement. You would feel more comfortable if they could live somewhere cleaner, safer, more convenient and, preferably, that has a spare room where you could stay when you visit.
If you can afford it, rather than have them fritter away their salaries on rent, which forces them to continue hitting you up for cash, it might make sense to buy your children a house or apartment. Not only would it give them someplace affordable and decent in which to live, but many financial advisers suggest that buying your children a home–or lending your children the money for a home–could be an effective way of teaching them a lesson in financial responsibility. Even better, it could be financially advantageous for you as well.
Real estate agents across the country say they’ve seen a notable increase in parental real estate purchases for kids in recent years because of the low interest rates and the struggling stock market. However, in towns such as Chicago and Boston, where there are large universities (as well as places like Los Angeles and New York where college graduates tend to settle), local brokers say it was common to see such purchases even before interest rates plunged and the stock market sank.
“We’ve always seen a bit of this,” says Nancy Thomas Nancy Thomas , a real estate broker with Koenig & Strey GMAC in Chicago. “With rates as low as they are, it makes more sense now, but even in the past parents felt better knowing that if their son or daughter was keeping odd hours in medical school, at least they knew they were coming home to a nice neighborhood with a nice apartment and a doorman.”
Of course, depending on the market and how much you want to spend, you may even consider buying a slightly larger property as an investment. Some parents, for example, may wish to buy an apartment or house with multiple apartments–their child can live in one, while the remaining units can generate rental income.
Depending on how the transaction is structured, there are other ways to purchase real estate for children so that it can be financially beneficial for you.
We asked a variety of financial advisers and tax attorneys the best ways to go about such an investment, and we got a variety of responses, which mainly boiled down to two basic suggestions: First, assuming you have enough liquid assets to cover the purchase price of the property, you can effectively act as the mortgage lender to your children by loaning them the money to pay for the house, which they can then pay you back over time; and second, you and your spouse can make a cash donation for a down payment on a house, which would allow you to avoid the gift tax, and which may eventually lessen your estate tax burden.
In the former scenario, the house and the mortgage are in the child’s name, while the parent acts as the mortgage lender. Unless a parent wants ownership of the house (which would only increase the size and value of his or her estate), it’s not necessarily advantageous for the parent’s name to be on the title.
The advantage to becoming your child’s mortgager is that you can lock down favorable rates at the applicable federal rate–currently just above 5%–which is often slightly lower than commercially available rates. (Presumably, parents won’t need or want to make a large profit off the loan, so they can afford to set the interest rate lower than mortgage lenders who must charge enough interest to make a profit.) Be warned: Make sure your child pays you back at the applicable federal rate unless you want the Internal Revenue Service to come sniffing around. Even at the applicable federal rate, though, it will still save your child money in the long run.
Besides getting a competitive rate, your child also gets the tax benefits of the mortgage interest tax deduction (which allows home buyers to deduct the interest from a mortgage from their income, thus lessening the tax blow). One common mistake in this scenario, however, is that many parents assume if they help out their kids by paying the mortgage, they get the tax advantages. Not so, says Sherwin Lesk Sherwin Lesk , a financial planner with Leonetti & Associates , a private financial planning firm in Buffalo Grove, Ill.
“That’s a trap many people fall into,” Lesk says. “A parent can’t deduct real estate taxes or mortgage interest, even if the parent is paying such items, if [he or she] is not on the mortgage or does not own the home in which the child lives.”
The second scenario–loaning your child the down payment outright–is ideal for parents who are primarily concerned with decreasing the size of their children’s estate tax burden after their death, but who want to help out with a down payment at the same time. According to the tax law, a parent can make annual gifts of up to $11,000 per person, and if both parents give to the cause, they can collectively donate $22,000 without being punished with the gift tax. Although a $22,000 down payment is significant in itself, it can be greater yet. If the child is married, the spouse of the child is also eligible to accept $22,000 in cash gifts from both parents.
Thus, collectively, a young married couple could collect $44,000 in gift-tax-free cash from parents. And if the gift is spread over the new year, it can be increased to double the amount–up to $88,000, with $44,000 coming in before Dec. 31 and the other $44,000 coming in after Jan. 1, thus allowing a child to put down an $88,000 payment on a home, which in most markets can buy quite a lot.
The disadvantage to just buying your child a home outright is that, depending on how large an estate you plan to leave behind, over the course of a lifetime, individuals are legally permitted to give away $1 million tax-free (that does not include the annual $11,000 gift exclusion). Although the single purchase of a $500,000 home falls well within the $1 million limit, it leaves little wiggling room for giving away tax-free cash to other family members.
We searched a variety of markets where people are most likely to move after college (such as Boston, Chicago, San Francisco and New York) and profiled an apartment or house from each market in the $500,000 price range that would make a nice starter home for your child. A final incentive for helping your kids buy a house or apartment is that, hopefully, they will one day be able to sell it for more than the original purchase price, garnering a profit that they can put towards a new, larger place, which one day might even be filled with grandchildren.